The bidder‘s decision on the composition of the supervisory board of the target company

First published in Noerr Public M&A-Report 01/2023

The appointment of its own representatives to the supervisory board is a typical measure by which the bidder exercises its acquired influence on the target company after the completion of a takeover bid. These personnel decisions are influenced by a legal framework that has become increasingly complex in recent years. In addition, the bidder must take into account that its decisions will be closely monitored not only by the boards of the target company but also by the public. Against this background, we would like to take a look at the legal framework for these appointment decisions in our focus article. First, we will look at the timing and procedure for replacing supervisory board members and then at the legal requirements for the bidder‘s representatives on the supervisory board.

Timing and procedure for replacing supervisory board members

Replacement after expiry of the previous members‘ term of offce

When and how the supervisory board of the target company is to be reshuffed is a question that a potential bidder should consider early in the process. Two points in time are of importance in this analysis: firstly, the end of the current supervisory board members‘ terms of offce, and secondly, the expected closing date of the offer, i.e. the moment when the bidder assumes control. Typically, supervisory board members‘ terms of offce end at the close of an ordinary general meeting specified in the appointment resolution. Furthermore, it is still common practice in German listed companies to elect all supervisory board members of the shareholders at the same time with identical terms of offce. If the terms of offce end close to the planned closing date of the offer, a bidder can leave the existing supervisory board in offce for a transitional period and only appoint a new supervisory board at the relevant general meeting (in the context of the supervisory board elections scheduled for that meeting). An argument against this approach is that the closing date of a takeover or mandatory offer cannot be planned exactly, in particular if regulatory approvals (e.g. antitrust clearances) are required or changes to the offer become necessary (most recently, this has become relevant especially in cases of changes to a minimum acceptance threshold). It may then happen that the bidder has not yet acquired the targeted level of shareholding when the cut-off date relevant for participation in the general meeting occurs and therefore does not (yet) have the required majority of voting rights in the shareholders' meeting.

Resignation and judicial appointment

The replacement of supervisory board members can be better structured if the bidder acquires some of the shares of the target company in blocks on the basis of purchase agreements concluded in connection with the offer. Then the sellers can undertake in the share purchase agreements to work towards the resignation of supervisory board members with effect from the closing date or, in any case, on the closing date with effect from a later date. A „hard“ obligation on the part of the seller will usually not be enforceable because the supervisory board members must exercise their offce personally and are not bound by instructions from shareholders. In practice, however, the aformentioned obligations to work towards the resignation of supervisory board members usually work well. After the resignation takes effect, the new supervisory board member can be appointed by court pursuant to sections 104 et seq. of the German Stock Corporation Act (Aktiengesetz; “AktG”) , which shareholders can also apply for. This is easily possible if the supervisory board becomes inquorate due to the resignations because the court is then obliged to appoint new supervisosry board members (section 104 (1) AktG). If, on the other hand, the quorum of the supervisory board remains unaffected by the resignation, a court appointment of a replacement can only be considered if three months have elapsed since the vacancy occurred or if there is an urgent case (section 104 (2) sentences 1 and 2 AktG). Frequently, an urgent case is deemed to exist after a takeover has just been completed, for example, if decisions must be made on structural measures, in the target company, the annual financial statements must be adopted or a transaction requiring approval is to be concluded. The requirements for urgency set by case law and literature are not excessively high. If an urgent case does not exist from any conceivable point of view, however, a judicial appointment can only be considered if the three-month period has expired.

Dismissal and new election by extraordinary general meeting

A rarely used alternative to judicial appointment is to hold an extraordinary general meeting at which incumbent supervisory board members are removed from offce and new supervisory board members are elected. This approach by the new majority shareholder can be perceived as aggressive and will only be considered if amicable solutions have failed. The convening of a general meeting may be requested by one or more shareholders who hold more than one-twentieth of the share capital and who have held these shares for more than 90 days prior to the receipt of the request by the company (section 122 (1) AktG). There are no further material requirements for a request to convene a general meeting; however, the request must not constitute the abuse of a right (which is often controversial in such cases). The only pre-requisite for dismissing supervisory board members is that the general meeting adopt a resolution with a majority of three-quarters of the votes cast (or another majority specified in the articles of association). New supervisory board members can be elected by a simple majority resolution of the general meeting. The disadvantage of this variant is the relatively long duration of the procedure and the negative external effect („battle for the supervisory board“), especially if the parties involved issue statements and press releases on the procedure or on the candidates in addition to the obligatory publications.

Requirements for the bidder’s representatives on the supervisory board

Regarding the legal requirements for the supervisory board members to be proposed by the bidder, two sets of standards must be distinguished.

Personal requirements

On the one hand, there are legal requirements for supervisory board members that must be observed. Only natural persons with full legal capacity may hold a supervisory board mandate (section 100 (1) AktG). The AktG provides for impediments to the acceptance of a supervisory board mandate in certain cases (see box „Legal obstacles“ on the following page). Further personal re-quirements for supervisory board members may be laid down in the articles of association, but this is not of great relevance in the practice of listed companies. If these requirements are not met by a candidate, the resolution of the general meeting on that candidate‘s election is void in the case of violations of sections 105 (1), 100 (1), (2) AktG, and contestable in the other cases. A resolution on the appointment of such a candidate by a court would be unlawful and could be challenged by appeal. In the case of non-regulated companies (More extensive requirements apply to regulated companies, e.g. according to Section 25d (1) of the German Banking Act (Kreditwesengesetz; “KWG”) for the supervisory board members of institutions, financial holding companies or mixed financial holding companies within the meaning of the KWG), the law does not explicitly stipulate requirements for the expertise of the individual members. Section 100 (5), 2nd half-sentence AktG merely stipulates that the members of the supervisory board as a whole must be familiar with the sector in which the company operates.

The Federal Court of Justice (German Federal Court of Justice, Judgement dated 15 November 1982 - II ZR 27/82, BGHZ 85, 293 = NJW 1983, 991) has derived from the requirement that supervisory board members must exercise their office personally (section 111 (6) AktG) and that a supervisory board member must possess or acquire the minimum knowledge and skills necessary to understand and properly assess, even without outside assistance, all business transactions that normally arise. Admittedly, this only sets very low requirements, the fulfilment of which is not in question in practice.

The requirement that at least one member must have expertise in the field of accounting and at least one other member must have expertise in the field of auditing may also be relevant for the bidder’s appointment proposals to the general meeting or to an appointing court (section 100 (5) AktG). The supervisory board member in question has the required expertise if he or she is or was professionally involved in accounting and/or auditing. Predominantly, this requirement is not understood as a personal requirement for a specific member (since it is directed at the board as a whole), but as an objective rule for the composition of the board. Nevertheless, resolutions of the general meeting that do not comply with this rule are regarded as contestable by the prevailing opinion, and in the case of judicial appointments the court must follow the rule as a restriction on its discretionary powers.

Further requirements

On the other hand, the personal requirements for supervisory board members of listed companies are varied and more extensive and arise from very different legal sources. Careful attention must be paid to the legal consequences of noncompliance with these requirements.

A strict requirement exists in the form of the fixed gender quota, which applies to listed companies covered by the Co-Determination Act, the Coal and Steel Co-Determination Act or the Co-Determination Supplementary Act (i.e. companies with more than 2,000 employees on a regular basis or in the mining or iron and steel producing industries). If it applies, the supervisory board must be composed of at least 30% women and at least 30% men (section 96 (1) sentence 1 Corporation Act). Election resolutions of the general meeting that violate this requirement are null and void, and the court is also bound by the gender quota when appointing supervisory board members by court order.

Finally, further requirements may exist due to non-mandatory regulations. This is the case if the target company complies with certain recommendations of the German Corporate Governance Code (The comments on the DCGK refer to the version of 28 April 2022, which was published in the Federal Gazette on 27 June 2022) (Deutscher Corporate Governance Kodex; “DCGK”). The DCGK contains a number of recommendations for the composition of the supervisory board (see box to the right), in particular with regard to the independence of its members. Furthermore, C.1 sentence 1 DCGK recommends that the supervisory board specifies concrete objectives for its composition and develops a competence profile for the entire body. Furthermore, for listed companies that do not fall within the scope of application of the fixed gender quota, there is an obligation for the supervisory board to set a target for the proportion of women on the supervisory board (section 111 (5) AktG). Both requirements have in common that they only exist if the supervisory board has determined this by declaring in the declaration of compliance pursuant to section 161 of the German Stock Corporation Act (AktG) that it will follow the recommendation in question and it has set a target figure for the proportion of women that is greater than zero. Thus, both requirements serve to bind the supervisory board itself, i.e. they do not have any direct legally binding effect on a shareholder. However, they have a significance for corporate policy, because it is to be expected that the supervisory board will position itself against proposals to the general meeting or the appointing court for appointments that contradict these requirements.

Recommendations of the German Corporate Governance Code for the composition of the supervisory board:

• Age limit to be determined by the supervisory board (section C.2 DCGK);
• Observance of diversity (section C.1 sentence 2 DCGK);
• Expertise on sustainability issues of importance to the company in accordance with the competence profile of the supervisory board (section C.1 sentence 3 DCGK);
• Membership of an appropriate number of independent members (section C.6 DCGK);
• Independence from the company and the management board of more than half of all shareholder representatives (section C.7 DCGK);
• Independence of at least two shareholder representatives from the controlling shareholder in a supervisory board with more than six members (section C.9 (1) sentence 1 DCGK);
• Independence of the chairperson of the supervisory board, the chairperson of the audit committee and the chairperson of the committee dealing with management board remuneration from the company and the management board (section C.10 DCGK);
• No more than two former members of the management board on the supervisory board (section C.11 DCGK);
• No board or advisory functions or personal relationships with significant competitors (section C.12 DCGK).

Legal obstacles

No person shall be a member of the supervisory board of a listed stock corporation who:

• is a member of the management board, a permanent deputy of members of the management board, a holder of a general commercial power of attorney (Prokurist) or a person authorised to act on behalf of the company in all aspects of its business (section 105 (1) AktG);
• is already a member of the supervisory board of ten commercial companies which are required by law to form a supervisory board (section 100 (2) no. 1 AktG);
• is the legal representative of a company dependent on the company (section 100 (2) no. 2 AktG);
• is the legal representative of another corporation whose supervisory board includes a member of the company‘s management board (section 100 (2) no. 3 AktG); or
• has been a member of the management board of the company in the last two years; unless his election is proposed by shareholders holding more than 25 per cent of the voting rights in the company (section 100 (2) no. 4 AktG).

Conclusion

A new composition of the supervisory board following the completion of a takeover bid can be achieved after the resignation of members by means of a new election at a general meeting or by court appointment. Ideally, the bidder will succeed in persuading existing shareholders to work towards the voluntary resignation of certain supervisory board members. When selecting candidates, the bidder must comply with a number of requirements on different legal levels. Only some of these requirements are mandatory (such as the personal grounds for disqualification). In addition, there are a number of requirements that a bidder can override (such as the requirements of the DCGK or targets for the participation of women set by the supervisory board). However, if the bidder chooses to do so, there may be opposition from the target company’s governing bodies. Whether the bidder wishes to engage in such a confrontation is at its discretion and should be carefully considered.